What Narendra Modi’s election victory means for surging Indian stocks

Indian stocks have been on a tear in 2014, rallying sharply as investors bet on a change in leadership in national elections. This week, Indian voters delivered that change.

Narendra Modi

Narendra Modi is set to become India’s next prime minister after an alliance led by his Bharatiya Janata Party crushed the Congress party, which has held the reins of power for most of the country’s history since independence.

Here’s what you need to know:

Who is Narendra Modi?

Modi is a controversial figure. He has been described as a “pro-business go-getter,” which should cheer markets. But he has also been tainted by violent religious clashes in his home state of Gujarat. Modi is a lifelong member of a Hindu nationalist group and made speeches as a young politician that helped stir up Hindu fervor against Muslims, the Economist recounted in a recent profile.

In 2002, religious riots in Gujarat killed more than 1,000 people. Modi denied accusations that he did little to stop the violence and a court said there wasn’t enough evidence to prosecute him. Modi has been denied entry to the U.S since 2005 over his handling of the incident, but The Wall Street Journal reported that he would now be granted a visa as a head of government.

On equity, we believe that a strong government will help mitigate bureaucratic risk aversion, reversing policy paralysis, in addition to jumpstarting the weak investment cycle. We raise our Dec 2014-end Sensex target to 27,200 from 24,700, offering a potential ~10% from current levels. Short-term catalysts for the market will be: 1) cabinet formation; 2) the budget; and 3) potential policy announcements. Sector wise, we reiterate our preference for rate cyclicals, which we expect to benefit from higher growth expectations, a compression of credit risk premiums and potential fiscal consolidation.

Strategists at Societe Generale took the opposite tack, arguing it’s time to book profits:

We now advise investors to rotate out of India for what we currently regard as more attractive opportunities in Asia, like
China, where we expect a rally in the second half of 2014.

SocGen sees the Sensex ending the year at 25,000, then gaining 10% in 2015 to 27,500.

What does it mean for the economy?

Modi downplayed religion in the election campaign, focusing on economic issues. He tapped into frustration with slow growth and widespread corruption. Strategists at Nomura offered a pretty upbeat assessment:

We believe that growth has bottomed out and better exports and a pickup in investment should drive a recovery from 2015 onwards. We are revising up our FY16 (year ending March 2016) real GDP growth forecast from 5.7% y-o-y earlier to 6.5%, from 5.0% in FY15. Faster decision making and reforms, along with prudent monetary policy should gradually correct India‘s macroeconomic imbalances. Economic fundamentals change slowly, but as they do, they should feed off each other and unleash other positive indirect effects on the economy. Hence, India appears at the cusp of a revival of the multi-year growth cycle from 2015 onwards.

Analysts at Deutsche Bank were more circumspect. They noted that, historically, economic growth has tended to pick up steam after elections, with the rupee gaining ground and foreign institutional inflows picking up. But they warn that foreign investment can’t be taken for granted and that without it, Modi can’t assume growth will pick up.

What about the rupee?

After plunging late last summer as emerging markets were rocked by the U.S. Federal Reserve’s tapering plans, the rupee has rebounded sharply. The rupee jumped Friday and added to gains on MOnday, leaving the U.S. dollar
/quotes/zigman/4868630/realtime/sampledUSDINRdown more than 5% since the beginning of the year versus the Indian currency. The rupee traded Monday at a rate of 58.50 per dollar.

The rebound is seen creating a new headache for the Reserve Bank of India, which had previously scrambled to shore up the rupee by hiking import duties on gold and taking other measures.

The Nomura strategists argue that the electoral backdrop and other factors point the way to further gains for the currency:

We forecast USDINR to reach 57.0 by end-2014 and 55.5 by end-2015 as beyond the strong mandate for the new government, domestic growth momentum should continue. The relaxation of gold import restrictions, below-normal rains owing to likely El Nino and unfavourable INR FX valuations are the key risks to our constructive INR view.

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